Thursday, July 22, 2010

XXV and the New VIX ETN Landscape

While I was out of pocket for a few days, Barclays had the temerity to launch a new VIX ETN. Not only that, but this new volatility product is the first inverse VIX ETN to hit the market. It goes by the formal name of Barclays ETN+ Inverse S&P 500 VIX Short-Term Futures ETN and has a ticker of XXV.

Others have already weighed in on XXV, including excellent coverage of the potential of this ETF from Adam Warner at the Daily Options Report, particularly in To Err is Blog-Human and XXV Finale. Another interesting post comes from Volatility Futures & Options and attempts to reconstruct the historical performance of XXV in XXV – Inverse VXX ETF First Day of Trading. Not to be outdone, Ron Rowland of Invest with an Edge asks some pointed questions of the branding approach at Barclays in XXV: Barclays Abandons iPath Brand with Inverse Volatility ETN.

Frankly, there are a lot more questions than answers for XXV at this stage. My initial impression, however, is a positive one. Both VXX and XXV are ideally suited for the day trading crowd and are useful for swing trades of several days or so. As far as longer holding periods are concerned, I am partial to XXV over VXX, as XXV should benefit from the same term structure rebalancing anomalies that have plagued VXX and have resulted in negative roll yield. In the case of XXV, the daily portfolio balancing should be a net plus over the course of long-term holding periods.

Several more VIX ETNs are in the works. In the graphic below, I attempt to outline the VIX futures (with the VX prefix) and ETN landscape, along with the two SPX implied volatility indices. Note that the volatility indices (VIX and VXV) both have a constant duration, as do the VIX ETNs: VXX; VXZ; and XXV. The duration of the VIX futures, however, decreases one day at a time (and jumps forward on weekends and holidays), which means that their time horizon continues to decline over the course of each VIX options (and futures) expiration cycle, which are represented by the large green arrows in the graphic. The bottom line is that when you have constant duration products, such as the VIX ETNs, which are priced off of declining duration products (VIX futures), then there will always be friction from the result of the portfolio rebalancing used to maintain a constant duration. The exact impact of the rebalancing depends upon whether the VIX futures are in contango or backwardation and the slope of the term structure. As a rule of thumb, the ETNs with the shortest duration (to the left in the chart below) will be impacted the most by contango and backwardation, while the ETNs with the longest duration (to the right) will be affected to a smaller degree by roll yield.

Finally, it is important to note that more VIX ETNs are on the way. The Jefferies S&P 500 VIX Short-Term Futures ETF (VIXX) targets a constant 30-day duration and has a great deal in common with VXX, while Bank of America’s Investable Volatility Index ETN (no ticker designated, to my knowledge) appears to be targeting VIX options (a first for this product category) with an average maturity of five months. CBOE has some skeleton information on their Investable Volatility Index (VOL), but I look forward to more digging up more details on the forthcoming ETN and sharing them when I do.

For more on related subjects, readers are encouraged to check out:

Disclosure(s): long XXV and short VXX at time of writing

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